Online Lending at AltFi: A New Phase for a Growing Industry

When I realized the 2016 AltFi Conference was at the posh Pierre Hotel on the corner of Central Park, it immediately gave me pause. I remembered 2007 and 2008 when certain mortgage-backed security investment conferences were held at such addresses. Also, is the storied (and stodgy) Pierre Hotel, the appropriate venue for the “alternative finance” conference? Oh well, I still wore jeans and at least the food was certain to be good.

Upon arrival, what stood out were the conspicuous absences. While no one expected to see Lending Club on the sponsor board or its representatives on a panel, other staples in the industry were conspicuously missing. Noteworthy absentees from former years were SoFi, Dealstruck, OurCrowd, Symbid, LendKey, Biz2Credit, OneVest, Realty Mogul, Assetz Capital, CommonBond, Seedrs, Crowdcube, P2BInvestor, and Zopa. Is this due to the Lending Club scandal earlier this year and the aftershocks it sent through the industry or simply natural market mechanics where certain winners no longer need to participate in such events and certain losers are not around any more?

One comforting element that provided a sense of institutional consistency was Ron Suber, of Prosper Marketplace, presenting the opening keynote. Suber has often been a champion of the industry, and he reassured the audience saying that the industry must get past this “year of turbulence.” He likened marketplace lending to Boeing in 2013 when it manufactured faulty batteries for its new Dreamliner aircraft. He noted that loan volumes are increasing, loan values are coming back and quality securitizations are back since the second quarter of this year.

He also noted that the industry needed to focus on developing a deep liquid secondary market, securitizations with a cusip and a rating so that institutions with certain investment criteria can invest, and properly executed derivatives and synthetic market. When pressed on this latter point, Suber clarified that “if done poorly or wrong, synthetic derivative instruments on assets produced by online marketplaces for credit will be detrimental to the industry.” This statement helped assuage my aforementioned 2008 déjà vu.

A few years ago, I wrote about Suber’s “Necessary Nine” criteria for a successful marketplace lending platform. Today he offered a new necessary nine, essential for funds looking to invest in this asset class, many of which were tested earlier this year. They are as follows:

Proper loan valuation – did they value them correctly?

Adequate accruals for defaults – in the second quarter, many didn’t set these correctly and had to true up accruals

Effective loan selection – obvious

Account for platform performance – many struggled with losses exceeding projections and this was felt by the funds that invested in them

Fund fees – are these billed and set up correctly?
Manage use and cost of leverage

Manage use of cash – many funds stopped purchasing new loans and experienced a cash drag

Purchase price of loans (premium vs. origination fee) – borrowers prepaid and many funds never realized those premiums they anticipated

Currency hedge – Brexit affected many funds who did not hedge against currency fluctuations

Suber then focused on the question of a “silver bullet” and if there is a particular structure for a platform that works the best between a pure online marketplace which takes no balance sheet risk and simply collects fees and a balance sheet lender that retains the loans. He settled on some form of hybrid that would have the flexibility to adapt to the current environment. He then projected that soon very big players such as Goldman and JP Morgan would be entering this space.

As final thoughts, he left us with four things the industry needs to get right:

Risk management groups – meaning the industry needs to ensure that it has appropriate safeguards when it comes to legal, compliance, data and other risks

Sustainability/profitability

Equilibrium (between borrowers and investors) – platforms need to be able to balance supply and demand

Trust and transparency

The fist panel addressed alternative finance assets and where they sit in the broader investment landscape. Simon Champ, of MW Eaglewood Europe LLP, commented that often (especially in the UK) marketplace lending assets are classified as an equity instrument, but are better characterized as fixed income. The panel had a basic consensus that liquidity is a primary issue, which makes these assets look like private equity instruments with a fixed income return. One point of concern occurred when Etienne Boillot of Eiffel eCapital was asked what effect would a bond market crash have on his funds; he stated “none.” Again that old 2008 feeling started creeping in. To be fair, he was giving a glib answer since his fund or funds are comprised of private assets, which are not publicly traded and not valued on a regular basis and thus would not be priced in such a “crash.” However, this is far too simplistic, and the marketplace lending industry has a correlation to the public bond markets and broader capital markets as a whole, which shouldn’t be overlooked.

The next speaker was Rupert Taylor of AltFi Data who discussed the current standards of disclosure and the need for what he calls the “4 C’s” – comparable, consistent, consumable, and credible data for investors.

In the next panel titled “In defense of online lending” the panelists were asked, “what value does the platform bring?”

Christian Faes of LendInvest, answered that it was the ability to originate loans online and streamline the previously grueling process of origination and underwriting. Eric Thaller of Prosper Marketplace explained that it simply helps borrowers get lower rates, and it helps investors get access to assets that have historically sat on a bank balance sheet. Nat Hoopes of the Marketplace Lending Association felt that the online model allows for greater operational flexibility and the ability to adapt to changes in both borrowing and investing trends.

The next panel focused on the evolution of the marketplace lending industry. Rupert Taylor once again chimed in regarding the need for more transparency in the industry, and that what exists now is not sufficient because “standards are ill-suited in what they are attempting to achieve.”

Bill Ullman of Orchard confirmed that platforms have not standardized information and investors need standardization to be able to compare data across the industry.

According to Charlie Moore, of Global Debt Registry, investors are starting to demand more information and in different ways, such as via APIs, etc., and the events of the second quarter of this year showcased the need for standardized loan disclosure and third party verification.

The third keynote of the day was Albert Periu of Funding Circle US, whose focus was on the need for diversity of funding sources for platforms. He also shared that since formation in 2010, Funding Circle has lent over $2.5 billion to over 20,000 businesses. Periu conceded that diversification of funding sources is difficult to achieve but is the only way marketplace lenders can scale. Periu was optimistic that the largest pools of permanent capital have yet to play a meaningful role in the marketplace lending ecosystem. These pools are endowments, sovereign funds, pensions, banks, family offices, insurance, and governments.

In his final remarks my ears pricked up when he mentioned that while Funding Circle has used retail investors as a source of capital in the UK and EU for some time, they will soon be utilizing such investors in the US as well. I am quite curious as to how they will achieve this due to the current regulatory regime. Will they try to use some private exemption or do a full registration similar to Prosper and Lending Club?

The final event of the morning session was a debate of sorts about the importance of retail investors to the future of marketplace lending between Peter Renton of LendAcademy and David Stevenson, of AltFi. Stevenson argued that accessing retail investors brings the ire of regulators and that the herd mentality of retail investors causes them to be less permanent. Renton countered that institutional investors are less sticky and move massive amounts of money at a time causing volatility, and further, that the financial crisis was driven by institutional investors and not retail investors. Renton proffered that open-ended mutual funds are the solution to accessing retail investors in a responsible, sustainable way. Stevenson dismissed the idea, stating that it does not work to mismatch a liquid investment vehicle such as a mutual fund with underlying illiquid assets such as online loans. Stevenson continued that managed accounts were all held by the big brokers, and it would be too hard for new entrants to break into the space because retail investors would never trust them. Renton’s final point was that there are currently over $12 trillion invested in IRAs and 401k accounts, and as individuals start to retire and draw down those funds, they will need a fixed income asset that pays more than 1%. It would not take a large percentage of such current retail funds to move into this asset class to create a meaningful shift. This point seemed to resonate with the audience, as it bumped the online audience poll to 44% agree that retail investors will become a more important source of capital to 56% feel that it will become less meaningful over time. I think it is obvious that it will become less and less significant, although I take the point that individually directed retirement assets could be a huge shift at some point, I just do not see it anywhere on the horizon.

All in all, I felt the conference lacked some of the energy of past years, which was a direct result of the Lending Club fallout and the market correction the industry experienced earlier this year. I do not, however, believe this is the beginning of the end, but perhaps a new phase that a growing industry is entering. This is a time for licking wounds, learning from mistakes and creating something stronger and more transparent than before.

Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.

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